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Brexit: A risky business?

As the UK prepares to leave the EU, how can manufacturers protect themselves against supply chain risk?

Recent statistics published by the Office for National Statistics and analysed by KPMG suggest that uncertainty surrounding Brexit has led to an increase in early signs of distress, particularly in the construction and manufacturing sectors.

With the risk of key suppliers or customers becoming insolvent, parties should consider carefully the potential risk of void transactions pursuant to Section 127 of the Insolvency Act 1986. This section provides that any payments or dispositions of a company’s property made between the date of presentation of a winding up petition and a winding up order are void unless they are validated by the Court.

In the case of Express Electrical, an electrical wholesaler and manufacturer, a winding up petition was presented against it on 23 May 2013. The company had fallen behind on the payment of invoices and the company refused to provide any further goods until payments were brought up to date. The company paid the wholesaler £30,000 on 29 May 2013, leading the wholesaler to lift the credit hold and supply further goods of £13,000. The company was later wound up in July 2013. The wholesaler applied for a validation order on the basis that the payment of £30,000 was made in good faith, in the ordinary course of business and whilst they were unaware of the petition.

This was unsuccessful, however, as the Court found that:

It was irrelevant whether the disposition was made in good faith and in the ordinary course of business

Save in exceptional circumstances, a validation order should only be made where it can be proved that the payment benefitted creditors

All cases where payments merely reduce arrears or pay invoices previously outstanding (and where no new goods or services are provided) are unlikely to pass this test.

Examples provided by the Court where a payment might benefit creditors included where payments enabled the company to fulfil its obligations under a profitable contract, where the payment otherwise swelled the assets of the company, or where the payment allowed the company to carry on trading when the sale of the business as a going concern was achievable.

If a customer or supplier enters an insolvency process it is imperative to understand the type of process that they are subject to (company voluntary arrangement, liquidation or administration for example) as each process will require a different approach.

Ultimately, however, insolvency law in the UK provides various remedies for liquidators and administrators of insolvent companies to set aside or overturn transactions for the benefit of creditors generally. Whilst there are arguments to be made in respect of each, the best defence is undoubtedly a structure of strong credit control procedures and investing in the identification of insolvency risks to avoid the position altogether.

There are a number of warning signs of supply chain risk, and it is key that you are familiar with these:

Is your supplier holding notably less stock, so that deliveries are short or late?

Are there signs that your supplier is subject to creditor pressure such that their creditors are repossessing goods and/or issuing winding up petitions?

Have you received a request to amend your terms and conditions (i.e. that title to goods does not pass until payment is received by your supplier’s supplier in full or payment terms are extended with your customers)?

Reduction in quality standards?

Official announcements to your supplier’s or customer’s shareholders or the stock market such as profit warnings

Large scale redundancies or the sudden removal of key personnel

How to protect your company:

Due diligence at the outset of a trading relationship can provide a benchmark against which you can measure any deterioration

Assessment of key customers and suppliers should be carried out regularly

Place limitations (where possible) on the amount each supplier provides

Keep direct contact with suppliers, customers and others in their sector so that you are informed of changes and/or deteriorations

Within your contracts, ensure that you have effective retention of title and all monies clauses (i.e. title to the goods does not pass until all invoices have been paid) and include sufficient powers to assist in retrieving such goods

Require customers to ensure that goods that have not been paid for are distinguishable and stored separately and mark your goods where possible for identification purposes to assist with your claim

Within your contracts, ensure that you have the right to terminate the arrangement on the occurrence of specified insolvency events